Blockchain technology uses peer-to-peer technology to send payments or data from one entity to another without the involvement of a financial institution or other central intermediary. It does it so that the data is completely secured, cannot be altered through fraud, and it does this efficiently -without excessive cost and time.
What if there were not only an internet of information, what if there were an internet of value some kind of vast, global, distributed ledger running on millions of computers and available to everybody. And where every kind of asset, from money to music, could be stored, moved, transacted, exchanged and managed, all without powerful intermediaries?
The concept of blockchain technology was originally created by Satoshi Nakamoto through the introduction of Bitcoin. The vision for Satoshi was to create a digital form of cash. Unlike cash however it could be used as a highly transparent and trusted form of currency that could be used without any third parties in between.
However, It’s imporatant to know the difference between what is bitcoin and what is blockchain. Bitcoin is the digital currency that uses blockchain technology to make itself work. (You may find the Blockchain ELI5 explanation worth a read also).
In one paragraph, blockchain can be described as follows:
“A blockchain is a distributed computing architecture where every network node executes and records the same transactions, which are grouped into blocks.
Only one block can be added at a time, and every block contains a mathematical proof that verifies that it follows in sequence from the previous block. In this way, the blockchain’s “distributed database” is kept in consensus across the whole network. Individual user interactions with the ledger (transactions) are secured by strong cryptography. Nodes that maintain and verify the network are incentivized by mathematically enforced economic incentives coded into the protocol.”
Blockchain technology can be thought of as a network, similar to the internet. Instead of servers and internet service providers, there are multiple parties set up as ‘nodes’ and ‘miners’ that play a big part in the network. Blockchain can be categories into the following two types:
Permissionless Blockchain — the open, decentralised blockchain. Anyone can join the network and participate in the network. Bitcoin and Ethereum are exaples of permissionless blockchains. On these blockchains anyone can operate as full nodes and start mining.
Permissioned Blockchain — a centralised authority allocates responsibility to individuals pertaining to operations of the blockchain. Therefore only a limited number of users are authorised to join the network.
How does Blockchain work?
When a transaction occurs it is broadcast to the network. Nodes then execute and record the same transaction across this decentralised network. The transactions are grouped into blocks (i.e. stored on the distributed open ledger). Generally only one block can be generated at a time, however, if you can imagine, multiple nodes may by chance generate a new block at the same time. In this case a temporary fork in the chain occurs.
Each block also contains a reference to the block that came immediately before it. It also contains a unique answer to a difficult mathematical puzzle. New blocks cannot be submitted to the network without the correct answer. The miners as well as bulking the transactions into the blocks also compete to find the answer to solve the current block. When someone mines a block they also earn a transaction fee- which serves as an incentive to continue to add transactions into the block.
Each block contains what is referred to as ‘proof of work’– a mathematical calculation that verifies the sequence and the validity of the previous blocks before it. As every node in the network is verifying the transaction the system becomes a shared ledger. Meaning that any transaction at any time can be validated by not just one central authority but by many.
Blockchain technology solves double spending
Double-spending is an error in a digital cash scheme in which the same single digital token is spent twice or more. This is possible because a digital token consists of a digital file that can be duplicated or falsified.
As with counterfeit money, such double-spending is Inflation by creating, during the duplication or falsification of the digital file, a new amount of currency which does not disappear when the original digital file’s currency amount is paid to a rightful receiver.
The duplication or falsification of the digital file may itself be perpetrated by a rightful receiver, in order to get paid one or more illegitimate amounts alongside a single legitimate amount. This devalues the currency relative to other monetary units, and diminishes user trust as well as the circulation and retention of the currency.
Say I want to send $100 dollars to you. To ensure that I have indeed sent the $100, you and I can involve an intermediary (a bank) to transact through. The bank will verify that I, and indeedI, have sent the $100, and forward you, and indeed you, the $100. BUT what happens when we want to remove this intermediary. Who verifies the parties, and who verifies the amounts, and who verifies that the funds have indeed been sent.
Moreover though, what if I tell you that I have sent $100, but this is a fake $100 bill or is a $100 bill that I my self do not own. This can be thought of as double spending.
Now, this may be harder to do with physical cash. But with digital files this is easily done. In fact we always send ‘copies’ of files, we do this when we send emails, PDFs, images, and other documents. But a digital currency, a contract, or any other asset that we do not wish to send copies of?
Blockchain technology does a great job of removing the double spending issue. It does this because all the nodes always accept the longest chain.
As I mentioned earlier, miners compete to generate blocks. As soon as a transaction is validated, it will add the block to the chain, thus making it the longest. So, if someone wants to put in a fraudulent transaction on the chain, they must generate a block faster than anyone else. This will make sure that their block gets added to the chain first- making it the longest chain.
In short, all the nodes on the network trust the longest blockchain and build their blocks on it. So if someone wants to override the longest blockchain, they must generate the fraudulent transaction faster than any a majority of other nodes combined, and validate the block, such that it creates the longest chain.
This, requires an enormous amount of computational power. In fact, you must have a majority of the computational power in the network to pull this fraud off.
Next generation technology
As described by Bitcoin founder Satoshi, Bitcoin is purely peer-to-peer version of electronic cash that allows online payments to be sent directly from one party to another without going through a financial institution.
The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power.
This is the basis for Bitcoin. However use cases for blockchain technology are much more than just as an online form of currency. Blockchain technology has given birth to several other cryptocurrencies or “alt coins”, each trying to present it’s own use-case.
With the introduction of Ethereum, which is another blockchain technology, users can actually do more than transfer currency.
Ethereum serves as a platform for creating decentralised blockchain applications. Similar to Bitcoin, it is an open source project.
It runs on a decentralised network such that no one controls or owns it. However it allows you to create your very own smart contracts and digital tokens (other cryptocurrencies).
Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.
These apps run on a custom built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middle man or counterparty risk.
In it’s simplest form, the blockchain is just a database. It’s a system that uses to timestamp and store data. So why the buzz and what separates it from a typical database?
Once the data is stored on the blockchain, it cannot be changed. The blockchain is a distributed open ledger system which has been verified by thousands or millions of nodes.
The network only accepts the latest and most longest chain that exists. Any change to any single data point along the chain will alert the entire network. Thus the blockchain cannot be altered.
On the other hand a traditional database stores data in a table. Anyone can change a cell value, and no one would potentially blink an eye. You can also copy databases like these very easily. In fact it’s done regularly in any software development environment or business. So it’s not too hard to change or alter any copy of the database to make it look legit.
Blockchain is possible through network of nodes. Although not necessary, it works by removing central control over it. This means that you don’t have one entity running it and managing it. Having said that, you don’t need all blockchains to be decentralised. Banks, institutions, and governments will find it useful to put applications on blockchain, without needing it to be run as a public blockchain.
The blockchain allows for complete audit-ability and traceability of transactions. Whether that is bad or good is beyond the scope of this article.
Blockchain creates trust in an untrustworthy environment. This is very significant in an environment where the transactors do not know each other or where trust is absolutely vital. Put simply, the blockchain (due to the network) acts as the complete source of truth. Therefore you don’t need an intermediary to verify all the parties involved.
Blockchain technology really is just in it’s infancy and users are finding smart uses of this technology. Potential for blockchain expands to where ever security, trust and immutability are important, such as with financial interactions, exchanges of assets, or exchanges of other services. All this could be carried out automatically and reliably using the blockchain. The ideas and opportunities being expored currently offer great possibilities. Some are being implemented as you read this, some are just ideas. But hopefully this article was enough to get you on the bandwagon.